Thoughts which don’t fit in 140 characters.

The Economic Crisis - Simplified

The amount of media attention that the global economic crisis has generated is worthy of creating a newsprint crisis by itself. Surprisingly, very few of these reports have actually tried to simplify the whole picture so that a common person is able to comprehend the economic crisis. One of the major causes of the crisis has been the fact that financial instruments have become so complex that even CEOs don’t get a hang of it. Even as the crisis unfolds, the media has failed to adequately simplify maintainig its tradition of keeping things complex.

Maybe its not all the fault of media. Because the crisis itself is so complex that everyone has a theory but no one has a concrete one. So, I will present mine (basically an adapted version of Thomas Friedman’s

It started with 9/11. The incident caused a major downshift in comsumer demand. To fight this deflationary sentiment, the Bush administration encouraged people to spend and give a boost to the economy. The housing market was a part of this greater plan. EVERYONE was offered a loan for a house. Many articles claim that the only condition to get a house loan in this phase was a desire to express it regardless of your credit-worthiness. With credit being so easy to avail, everyone wanted a home and got it. The housing market boomed. But Bush forgot to tell Americans to take their legs off the pedal! How could he? He was busy accelerating in Iraq and Afghanistan. And a bubble got created. Prices went up like a rocket. Very soon, people started defaulting on payments. Banks realized but they had already offered too many bad loans which were now defaulting. We got the first buzzword of this saga – subprime crisis Subprime, as I have been able to infer are that group of people whose credit worthiness is below that of a regular income group. A huge number of people were now defaulting and banks were losing huge amount of money. But how, they must have some guarantee?

They had. The house they financed was their guarantee. They seized it. But what next? As the crisis erupted, the housing bubble bursted and prices crashed. So a house funded for say Rs 10 million was only worth Rs 5 million now. Banks lost out Rs. 5 million. And unlike here in India, they couldn’t go seizing the person’s other assets to recover their loan.

You would have seen and read a lot of people aggressively that stock markets are only a hang-out of speculators and nothing more. They don’t have any significant impact on the common man. Hopefully all that aggression has given way to some meditation about the current crisis. As the subprime crisis grew in size, the sentiment in share markets became negative. People thought that it is more prudent to sit on cash at a time when several major financial institutions (Merill Lynch, Lehmann Brothers, AIG) are cracking up. This caused the markets to enter into a freefall. Our own Indian BSE Sensex is down from its high of 21000 to 9500 levels now.

This equity crisis led to huge losses for a lot of people. The profits they had earned throughout their lives got wiped out within weeks and months. This made people cautious and caused the next monster – demand crisis. Everyone had lost big amount of money? How? Very few people invest in share markets. Yes!! But, where do they invest? They invested in mutual funds and unit-linked insurance plans which are themselves based on share markets.I have written a post related to it earlier.

Now corporations started feeling the heat. Already with banks finding it tough to stay afloat, credit was tough to find and new projects were slowed down. With the depressed consumer demand and cracking stock prices, companies had to cut down on projection and revise their revenue projections. This eventually caused the employment crisis.

Never after the Great Depression in USA (1929-32) have all these crisises - housing, equity, demand and employment - occured together at this scale. This is why you feel the anxiousness in the voices of even the prettiest of news anchors. (Case in point - Namrata Brar on NDTV Profit. I haven’t seen another better mix of beauty with some really sharp economic brain. Yes, I have a crush on her. Lets get back.)

Finally, the most common confusion! With all this mayhem starting in USA and Western Europe, why are we getting involved. I can’t give a lecture on how the world has globalised and flattened and become inter-connected. (Buy Thomas Friedman’s “The World is Flat” - preferably through the LibraryThing link on your right. We will and have been affected. But that affect has been mitigated some what due to some prudent and watchful. You don’t get a loan easily in India unless you drive a BMW. There are zillions of formalities. And if you default once, your name (using the PAN card) goes on the black-listed credit database that all banks share and you won’t get another loan unless your dues (even credit card bills) are cleared. Anyways even if we got easy loans at some time, Indian mentality is not too look for too big too early. However, we got involved at the next stage - equity as a major portion of the money flow in our share markets comes from foreign institutional investors(FIIs). Hopefully our domestic demand will see us through this phase. But to completely restore order, I hope global leaders like Barack Obama, Gordon Brown, Nicholas Sarkozy, Hu Zintao and our PM Dr. Singh make a coordinated plan.